Here’s what could rattle the stock market this year

On Jan 17, 2022

Sure, it’s been a rocky start to the year on Wall Street following a stellar 2021. The Dow is down about 1% and the S&P 500 has fallen 2%. Trading has been volatile. But the Dow and S&P are still each just 3% below their all-time highs.

Tech stocks have had a bit more of a wild ride. The Nasdaq is down 5% in 2022 and nearly 8% under its peak, putting it closer to a 10% drop known as a correction.

Yet every time it looks like stocks could be heading for an even steeper drop, investors come rushing back in to buy the dips.

Traders have so far mostly shrugged off temporary concerns about inflation and the Federal Reserve getting ready to raise interest rates, as well as fears over the impact that the Omicron variant of Covid-19 may have on the economy. Earnings growth has remained strong in spite of these factors.

“It’s been a Teflon market recently,” said Bill Sterling, global strategist with GW&K Investment Management, referring to the notoriously non-stick material. “Expectations have changed a bit with a rate hike cycle beginning sooner but the market is discounting that.”

The Fed is in a high-stakes race to catch up to inflation

So what needs to happen to really rattle Wall Street’s nerves in a meaningful fashion?

“I’m not surprised by the market’s resilience because the fundamentals for earnings and the economy are still strong,” said Larry Adam, chief investment officer with Raymond James. “But the markets are due in many ways for a pullback.”

Adam said investors need to keep an eye on the Fed. If it has to hike short-term interest rates even more than expected because of inflation, that could create more market jitters.

“Investors may get nervous about more volatility,” he said. “If the Fed is more aggressive, that could spook the markets.”

Rising bond yields still could be a problem

The prospect of meaningfully higher long-term interest rates could also slow the economy and put a dent in stock prices.

It’s a bit unclear why the 10-year Treasury bond yield still remains relatively low, at just about 1.77%, given the chances of rate hikes and the fact that inflation is so high. Consumer prices soared 7% over the past 12 months.

“The bond market is a mystery now with where inflation is. I don’t think rates will remain at these levels,” said Steve Wyett, chief investment strategist with BOK Financial.

Republicans are much more worried about inflation than Democrats. Why that matters

Wyett added that investors need to keep an eye on Washington for the upcoming midterm elections in November. Investors may not be factoring in the possibility of more gridlock stalling stimulus efforts if Democrats lose control of the House and Senate, as some political pundits are predicting.

“We could have market volatility around the midterms, but that’s not in the forecasts just yet,” Wyett said.

Still, investors may continue to drown out any noise about politics, Covid and even inflation as long as corporate profits keep chugging along at a healthy clip.

According to forecasts from FactSet Research, analysts are still expecting earnings for the S&P 500 to rise nearly 10% from last year. Although that is a…